The Sharks Of Shark Tank Reveal How To Get Funded

You have just quit your high-paying corporate career. You’ve been flung into a world of uncertainty, brimming with a lack of security and full of unknowns. Maybe you over-stayed your welcome on a friend’s couch (like I have), barely pulled a salary for 12 months, or firmly established yourself as the number one customer of any establishment with a two-for-one special. Why? Entrepreneurship…

That niggle in the back of your mind to solve a problem close to the hearts of a specific segment of people or potential customers. That’s why.

Recognising that a number of different ingredients go into the creation of successful ventures, one such ingredient is suitable finance.

In Zero to One, Peter Thiel’s book on entrepreneurship, the following observation is made: “The 12 most valuable technology companies are all venture backed. Together, those 12 companies are worth $2 trillion — more than all other tech companies combined.”

The short of it is that finance, or getting funded, matters. According to the 2015 South African Venture Capital Association (SAVCA) survey, assumptions about funding availability in South Africa were confirmed. Dry-powder capable of being deployed by some of South Africa’s most eminent venture capitals and funds is being kept locked away in chests, buried deep and well out of the reach of prospective entrepreneurs and portfolio companies of such investors.

While the number of venture funds has increased by 40% (from 22 to 31) over the course of the past four years, average independent deal values over the same period have decreased by more than 7,5 times, from R25 million to R3,4 million per transaction, and total value invested in the particular ‘asset class’ by more than 45% (from R281 million to R146 million).

Why? Having started a number of entrepreneurial ventures, worked with South Africa’s most established venture capital fund, and currently assisting entrepreneurs to raise finance, some interesting patterns emerge.

Entrepreneurs are flagging the lack of available and ample risk capital, while investors point at a lack of quality entrepreneurs. Exposure to both perspectives can only lead to one conclusion: tThere is hope. If anything, the last six months have served to reinforce what was initially believed: through En-novate, (a venture recently co-funded and co-founded by Dan Brotman and Natan Pollack, in association with Investec), I have had the great privilege of gaining access to South Africa’s top entrepreneurial talent, which is far greater than often believed.

From the murkiness, a question emerges: if there is plenty of capital to go around, what is the key to unlocking interest in getting your business venture backed? More apt perhaps: how do you get funded?

Anecdotally, the following is important:

Venture returns are not randomly distributed; they follow what is known as a ‘power law’, where a negligible or small segment of a portfolio generates all, or the largest proportion of funds’ returns.

But the fact remains that 20% of investments drive more than 80% of returns. Investors are exclusively looking to find, back and grow this 20%. Your job is to convince any prospective investor that you are worth backing, and by virtue, fall within the ambit of the highly regarded 20%.

How to get funded

The following observations are drawn from my experience at the coalface of venture finance in South Africa; be it through unsuccessful five minute pitches, or long-nights around dimly lit boardrooms late into the early hours of the morning, ultimately yielding success.

1Foundations are key

Venture capital has always been good at funding the future. What does this mean?

The world’s most valuable companies have, among many, one thing in common — making peoples lives better: Important problems, being solved for a large base of sufferers in need of particular and fitting solutions.

100% of the world’s smallest market does not mean anything. You need to fundamentally understand and articulate why your solution exists, why it matters, and why it is going to get BIG. Technical talk splayed over a meaningless solution to a non-existent problem won’t fool anyone, especially astute investors who look at investments for a living. Moreover, some of the world’s most profound business models with the deepest of economic moats have come as a result of the ruthless pursuit of impact, not the other way around.

The entrepreneurs who get funded by the top investors understand this better than anyone.

Tip: Find those investors who are intent on making the future better, articulate your existence in that version of the future, and think about how your product, solution or service will assist in realising that future.

2Returns matter

Venture investors have their own base of investors to answer to, and to generate returns for. (Investors into venture funds are commonly known as Limited Partners, given the proclivity for venture funds to be housed in partnership structures.)

Furthermore, with so few venture-backed companies returning entire funds, you need to think about and construct your version of 10x.

Tip: Be able to answer why your business will generate a return of at least ten times the money investors initially look to provide. To some, this might seem out of kilter with known-knowns. The reality, however grim, is that very few investments make it big, and that investors need to look for and find those companies that ultimately will. Hence the need to understand why your company will be crucial in making the future better, be valuable for that very reason and therefore return multiples on money initially invested.

3Why you?

We often see entrepreneurs fixated on their product, their market, or perhaps the unit economics underlying the ability of their enterprise to capture economic value. For the most part, entrepreneurs forget the single constant in all venture-backed businesses: great people and the drivers behind their success.

Looking at the websites of some of the world’s most successful venture funds, or talking to any local investor, you will find one thing — it’s all about people and the founding teams that drive entrepreneurial ventures.

It’s not hard to see why…

The funny thing about early stage companies is the desire of such businesses to change and evolve over time, often way beyond the scope of what was initially envisioned. Investors know this better than anyone and look to find those people who will succeed above all else.

Great people shape the DNA of great companies. Without people, DNA does not exist.

4The three Ts

Team, Team, Team — Enough said.

5Research

As venture funds have become more widespread, and the asset-class accepted into the mainstream, an interesting pattern of fragmentation has started to emerge.

Among many, funds are being created and developed around frameworks that relate to the following: to gain exposure to specific industries; to acquire minimum ownership stakes; to become active in managing and running portfolio investments; or to apply capital for social good.

Tip: Allow your investment requirement, the stage of your business and your business’s industry application to drive and dictate your strategy in finding suitable investors. Just as ‘product market fit’ is important, so too is investment and investor, i.e. selling your business and vision to the right buyer or recipient. For the most part, information pertaining to investment requirements is to be found on the websites of venture funds.

Whatever the unique parameters of your situation, or that of your company, it is imperative to optimally match you, your company, and any investors you are looking to onboard. In short, this means understanding where respective interests lie, and ensuring that they are aligned with those of investors.

Instead of sharing your marketing materials or your financial model with the first result returned by a generic

Google search, think about:

How much equity you are willing to give away and why

Your industry, what your company would need to succeed (in addition to capital)

Strategic benefits that particular investors are able to provide in helping you ‘make it’

Whether you are looking to grow and exit from your business in the near-term, or create value for the long-term

How your business fits in with the existing portfolios of potential target investors

Your desire for investors to get more hands-on and deeply involved in the operation of your business.

And while the outline above is no guarantee to getting funded, thinking about these questions deeply and meaningfully is sure to get you better prepared, assist you in crafting a story that will resonate with the frameworks and language spoken by investors, and ultimately drive a higher probability of receiving a cheque from an investor that is burning to see you succeed.

If there are any takeaways to be had, it is this: think deeply about the process, your business and resist the noise. The most important asset you can have is the ability to think independently, however painful this
might be.

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Pay Your Dues Before Raising Capital

Did you know there are 10 billion mobile phones in the world? I have an idea for an app. If we only get 1% of the 10 billion users out there, I’ll have 100 million users and my company will be worth R1 billion. Will you give me R10 million for 5% equity? — Dave

Is this you? If so, pay attention: Market size does matter. But competition matters more.

Yes, there are billions of mobile phones in the world. Yes, there are great opportunities to be grasped. Yes, if you grasp them you will be rich.

The question is: How will you avoid competition? How will you ensure you’re not fighting hundreds of other well-funded, hard-working entrepreneurs? How are you different from the hundreds of others that chased the same idea and failed without trace?

Assuming that by some miracle you find a niche in which you’re the only player, the next question is: How are you going to let people know about your product? How will you raise awareness? How will you market?

These are the questions to ask yourself before you ask someone else for investment. Otherwise you’ll look like a fool and fail. Or worse, you’ll find a fool investor and you’ll waste two years of your life, at the minimum, chasing an impossible dream and losing other people’s money.

I currently work on a mine in the Northern Cape. I want to make a device that allows mining machinery and people to interact/communicate, thereby increasing safety and efficiency. — Brendan

Good idea, nice niche (niches are good!) You’re talking about entering the IoT category (Internet of Things). A healthy place to be in coming years.

In my opinion, you don’t want to get into the hardware game. Rather plug into the APIs (Google it) of smart device vendors like Apple and Fitbit. When it comes to sensors/devices for cars, buildings etc, you can find some pretty affordable stuff out there. Good battery, low maintenance. You’ll need to research it yourself. The key is the software. Tying together all the watches and cars and buildings in order to improve efficiency and safety.

Making software is not wildly easy. If you’re not a software developer, you have three choices:

Pay for a developer to do it.

Give equity to a developer to do it.

Learn how to develop.

Option one is the cleanest and best. Your minimum viable product will probably cost about R200 000. If you don’t have the cash, postpone your dream. Don’t panic, the opportunity is not going away. Before you embark on your entrepreneurial journey, make sure you have enough cash.

I have compiled a marketing template. Kindly advise if the wording, language and clarity is on point. I had a second opinion saying it was not engaging, professional and has no actionable call. — Mam

Documents are useful for forcing you to distil your thinking, but they won’t get you a deal. Only face-to-face meetings get the deal. Only relationships get the deal.

Spending your life fine-tuning decks and docs is a form of procrastination and delaying the real thing: Sales.

If you win over the customer, the rest is just ‘ticking the boxes’. If you don’t win over the customer, the rest is just finding excuses to not give you a deal. Of course, you need your summary document. And it needs to be professional. And it needs a call to action.

But success will come from your ability to win over the customer (or investor). Don’t look to your documents. Look to your customer.

Alan Knott-Craig’s latest book, 13 Rules for being an Entrepreneur is now available.

What it’s about

It’s easy to be an entrepreneur. It’s also easy to fail. What’s hard is being a successful entrepreneur. For an entrepreneur, there is only one important metric of success: Money. But life is not only about making money. It’s about being happy. This book is a collection of tips and wisdom that will help you make money without forgoing happiness.

Get it now

To download the free eBook or purchase a hard copy, go to www.13rules.co.za. To browse Alan’s other books, visit bigalmanack.com/books/

Who Would Invest In Your Start-up, And Why?

When we launched Cielo MedSolutions, a SaaS provider of population management healthcare apps, in 2006, my co-founder and I assumed we’d be able to raise venture capital. After all, we both had track records of having built and run software businesses and making money for investors.

However, we failed to raise VC funds, and had to settle for a far more modest amount of capital from a combination of angels, economic development agencies, non-profits and federal grants.

Partly as a consequence, we grew considerably more slowly than we had hoped. We ended up with a nice exit – sold to The Advisory Board Co. (ABCO) a little over four years later – so nobody’s feeling sorry for us. But, it wasn’t the big splash we set out to create.

Why? Even I, as a student of the game, have had trouble gauging start-up investor interest.

This experience – combined with observing hundreds of other start-ups – motivated me to look more closely at these tough questions: As you’re thinking of launching a business, or looking to take your existing business to the next level, should you aspire to raise outside financing?

A quick, nerdy explanation

The x, or horizontal, axis of the Start-up Fundability Matrix indicates capital efficiency (ranging from low to high). All other things being equal, outside investors prefer to put their money behind a business that’s capital efficient, meaning that for every dollar invested, it’s good at producing strong returns on a dollar-for-dollar basis.

On this scale, the more “investable” businesses tend to be those that (a) require only a modest amount of capital to launch, and/or (b) can be scaled dramatically and efficiently by injecting just a modest amount of additional capital.

The y, or vertical, axis denotes valuation multiples (again, ranging from low to high). Valuation is the value of the company, or its overall financial worth to investors. Since early stage companies are privately held, and therefore don’t have a stock price you can look up on a public exchange, investors often use patterns from comparable companies to estimate the valuation of a start-up.

The most commonly used metric is the valuation multiple – that is, how much certain types of companies are typically worth, measured as a multiple of the last 12 months’ earnings (profit) or revenue (total sales). In general, businesses that achieve high valuation multiples are those that show three characteristics: High growth potential, sustainably high profitability and strong differentiation versus competitors.

So, now we’re ready to look at where various businesses fall in the Start-up Fundability Matrix. Here are the four quadrants:

Quadrant 1 (upper right): Venture Capital – Businesses have a combination of high valuation multiples and high capital efficiency — inexpensive to launch and/or inexpensive to scale; these startups are the most attractive to VCs, corporate strategic investors and organised angel groups (which often behave like VCs).

Quadrant 2 (upper left): Patient Capital – These companies share the high valuation multiples with Quadrant 1 firms, but are less capital efficient, often because they lend themselves to less rapid scaling due to addressing a more modest market.

These businesses tend to be better suited to investors who are more patient and perhaps less oriented toward pure financial returns – such as friends and family, specific angels with a special affinity for your particular sector, federal government grants, or state and local small-business loan programs.

Quadrant 3 (lower right): Bootstrap – These businesses rank relatively poorly on the scale of valuation multiples; on the other hand, they tend to be capital efficient (inexpensive to launch and scale). Think of Quadrant 3 firms as cash-flow or lifestyle businesses. It’s often possible to get such a business up and running with a modest investment out of savings or a bit of credit card debt.

Quadrant 4 (lower left): Dead Zone – Businesses here are extraordinarily hard for entrepreneurs to finance, and for good reason – they require a lot of capital to launch, and once up-and-running, are simply not that valuable. As a consequence, outside investors tend to run away from such startup ideas.

How I could have used this tool

Circling back to Cielo MedSolutions, we launched the company assuming we were in Quadrant 1, an “investible deal” for VCs.

We were wrong, because most healthcare IT-oriented VCs, while feeling comfortable with the high valuation multiples in our sector, suspected that we were too “niche-y” – addressing too modest a market – to be dramatically scalable post-launch.

Although we didn’t have the benefit of the Start-up Fundability Matrix at the time – and hindsight is 20:20 – what the VCs were effectively signaling to us is that we belonged in Quadrant 2.

We raised a couple of million dollars from a blend of “patient capital” investors. Had we known our “quadrant” up front, we could have saved a lot of time pitching VCs, and redirected our efforts toward selling to customers, building industry alliances and the like. Alternatively, this clarity of thought might have motivated us to explore broadening our product offering.

How you can use this tool

Applying the Start-up Fundability Matrix to your start-up can help you be clear-eyed about whether you should aspire to raise outside capital, and if so from what types of investors.

If you think you’re high on the y-axis (i.e., high valuation multiples), then the primary determinant of whether you’re in Quadrant 2 (Patient Capital) or 1 (VC) is market size. Narrow or niche product businesses push a company to the left (Quadrant 2), while very large addressable markets and broader product platforms tend to push a company to the right (Quadrant 1).

On the other hand, if your business ranks low on the y-axis (low multiples), the principle factor pushing you left or right on the x-axis is launch cost. Companies that can be launched with a modest amount of capital fall into Quadrant 3 (Bootstrap), while those that require large amounts of capital to build (e.g., to fund construction of a factory or a large store, and to purchase large amounts of inventory) fall into Quadrant 4 (Dead Zone).

At the earliest stages of company development, the Start-up Fundability Matrix can even help you think through the pros and cons of different business models.

If, for instance, you’re an entrepreneur with a passion for buying and selling used musical instruments, a Quadrant 3 approach might be to open a brick-and-mortar store, with all its associated overhead and geographic constraints. Tough to get financed, so you’ll probably need to bootstrap it.

Alternatively, you could pursue a Quadrant 2 (or even possibly 1) business model and create a re-commerce marketplace where your website enables sellers/consigners of instruments to find interested buyers.

By making that business model shift, you’re tying up less capital in a physical store and inventory, while broadening your geographic reach, profitability and scalability.

In this example, the latter business model may not only be more fundable, but stands a much better chance of being sustainably profitable, and eventually earning money for you while you sleep.

Looking For Funding? First, Understand What Funders Look For

Put two venture capitalists and an entrepreneur (who pitched her business to almost every VC in South Africa before securing corporate funding) in a room, and you’ll hear the truth about funding: What investors look for, the realities for business owners looking for funding, and what you can do to increase your chances of securing funding — or better yet, build a great business without it.

In June, the Matt Brown Show hosted a series of events, called Secrets of Scale at the MESH Club, focusing on what it takes to scale a business. Matt’s panellists included Clive Butkow, ex-COO at Accenture and CEO of Kalon Ventures, a tech-focused VC firm; Keet van Zyl, a venture capitalist and co-founder of Knife Capital, and Benji Coetzee, founder and CEO of tech start-up EmptyTrips. To add a twist to events, both Keet and Clive chose not to invest in Benji’s business when she was on the funding trail, even though they believe strongly in both her and her idea.

Here’s what we learnt from their experiences, insights and advice for local business owners.

Funders back the jockey, not the horse

This is a truth that Benji has experienced first-hand. “After months of trying to find an investor, I decided that VCs don’t know what they want,” she says. “The ladder of proof just keeps getting longer — big white space, addressable market, an MVP (minimum viable product), traction, first users — there’s a long checklist and you just need to keep ticking those boxes. Great concept, great team, we love it, keep going. I can’t tell you how many times I heard that.”

What Benji learnt was that the corporate funders who would eventually choose to back her were interested in two core things. First, did she have skin in the game? By that stage, she had invested R3 million of her own funds into the business, and so the answer was decidedly yes. She was already backing herself.

The second was that they wanted to back her — not necessarily the business. They were interested in her passion, dedication, experience and networks. “You still need everything I mentioned before,” she says. “But ultimately an investor backs the entrepreneur, not the business.”

Clive agrees. “There are a lot more million-rand ideas than million-rand entrepreneurs,” he says. “At Kalon, we’ve seen 600 companies and we’ve made four investments. That’s one to 100 odds, which is pretty standard in this industry.

“That doesn’t mean the 596 businesses we saw weren’t good businesses. Some of them were fantastic. They just weren’t investable businesses because we knew they wouldn’t give us a 10x return. They also weren’t 600 unique businesses — they were 100 unique businesses six times. There are very few unique ideas or even businesses out there — and so it’s the entrepreneur who makes the difference, and who you ultimately want to back.

“We look at three things in an investment. Is the deal investable? Is the person investable? Is the risk investable? If all three answers are yes, we can take it further. You need to have a great jockey; you need to have execution capability; and you need to have traction in a large target addressable market.”

Funders are interested in traction

“Every single business we’ve invested in had customers, and wasn’t just an idea,” agrees Keet.

The best way to prove traction and to get funders invested is to start introducing yourself before you need money, and then keep them up-to-date on what you’re doing and achieving.

“We receive five business plans via email a day for funding, and we ignore them all if they haven’t come through our network,” says Keet. “This isn’t unusual. 93% of deal flow in South Africa comes from within the VC’s network.”

Don’t think of a VC’s network as an exclusive ‘invite only’ club though. “Building a network is all about attending ecosystem evenings and embracing targeted networking,” says Keet. “We’re all on Twitter. Get to know us. I’m passionate about the journey of an entrepreneur — send me a newsletter telling me who you are, and three months later where you are now. That’s my passion. I love that stuff.”

More importantly, it’s not just a business plan — instead, you’re letting potential investors into your story, and giving them the opportunity to share in your journey.

“It’s not that difficult to get into networks and bump into people at events,” says Keet. “And then it’s much easier to send a follow-up email saying, ‘Hi Keet, we met last week at the MESH Club at the Matt Brown event, can we have a coffee?’ It’s tough to say no to requests like that.”

Clive agrees. His advice is to always meet your investors before you need money. “We don’t have the bandwidth for cold emails, but we do enjoy sharing stories and business journeys.

“Think about it like this: We don’t invest in dots, we invest in lines. Tell me where you are now and where you’re planning to be, and then keep updating me. You’re then able to prove that you can stick to your goals, execute on them, and hopefully even exceed expectations. Get that right, and funders will come to you.”

Clive also says that smart VCs play the long game, often supporting businesses even if they don’t believe the time is right to invest in them.

Both VCs used Benji as an example of this strategy in action. While neither fund was able to back EmptyTrips, both Clive and Keet have kept in touch, followed Benji’s growth trajectory, and supporting her where possible, either with advice or connections.

“Keet opened me to the angel network,” says Benji, “and his partner, Andrea, introduced me to Lionesses of Africa. It was that involvement that allowed us to build a relationship with Siemens and Deutsche Autobahn. VCs aren’t just about funding — they enable ecosystems too.”

Before you look for funding, make sure you actually want (or need) it

The most common question people ask Clive is, ‘How do I raise VC funding and from who?’ According to Clive, this is the wrong question to be asking. “Equity funding should always be a last resort,” he says. “The question business owners should be asking is, ‘do I need funding?’ The best way to build a business is through customer funding. Some businesses are capital intense, but I’ve built many tech companies with no external capital. Customer funding is gold.”

Even though Benji has needed additional capital to build her business, she has also learnt the value of starting with what your clients want.

“Businesses change and evolve. We started out wanting to fill trucks on the empty legs of their trips. I now manage more trucks than Imperial’s CEO, but we don’t own a single vehicle, because we’re a platform that connects transport operators with companies that need transport solutions. We’ve since built an open spot market and we offer insurance solutions.

“We spend so much time asking what VCs want — and I was guilty of this too — when we should be asking what our clients want and need, and then building those solutions for them. That’s how you get clients to fund your business.”

Creating traction, knowing what clients want, building a use case: These are all essential steps in the overall process, and they will either lead you to funding, or help you build a business that doesn’t need external capital.

Focus on what moves the needle

“The real trick to growth is focus,” says Clive. “Don’t try to do too many things. Go deep and drill for oil and gold. Once you’ve scaled a business and you’ve become the best at something you can start to expand. Too many entrepreneurs are easily distracted. Most start-ups don’t even know what they’re building until they start getting real customer feedback. If you’re doing too much it’s difficult to take that feedback in and adjust what you’re doing.”

Keet agrees. “Find your strategy, determine the key metrics you need to grow in, and then focus on growing those metrics — and only those metrics — aggressively.

“From a scalability perspective, the entrepreneur’s ability to execute their strategy is paramount. You need a good product, a large market, and to know where you’re going. You also need to be able to grow five key areas simultaneously: Customers, product, team, business model and funding. These need to grow in proportion if you want to succeed — which is where the ability to execute becomes so vital.”

“Scaling a business is always about the practical stuff,” says Benji. “Consultants and VCs always have acronyms — the 4Ps, 5Cs — I have the 5Es.

“First, you need an explicit purpose. Be clear on what you’re doing and why you’re doing it. Next, you need an effective model that makes financial sense. You need to achieve sustainability sooner rather than later, because the sooner you can fund yourself the better.

“Next is execution support, and this is all about having the right team behind you. You need to be able to execute fast — and that takes a team. It doesn’t have to be perfect; just get it done — done is better than perfect. That way you’re first and will hopefully stay ahead. I often call our customers to apologise for something we’re fixing on the platform and they’re always okay with it, because we’re the only one doing this, and we’re still building it up.

“This is followed by what I call ‘enveloped co-opetition’, which basically means working within your ecosystem. Work together with neighbouring industries. Grow together and support each other, even if you are also competitors. This actually opens doors.

“Finally, you need emotional resilience, because this is tough, and you need to keep at it if you want to succeed.”

TOP TIP

“We tend to fund older entrepreneurs who are more mature, understanding and generalists. You need resilience and the tools to succeed, and that often comes from having spent time in corporates, building up experience and a skills set.” — Keet van Zyl

Open additional revenue streams

As Benji mentions, the sooner you can fund yourself the better, so building a sustainable business is key. In addition to this, opening additional revenue channels can help pay the bills while your business gains traction.

“Scalable businesses are based on products or platforms, not services,” says Clive. “However, you can fund the product business with cash flow received through services. Ideally though, as the business grows, you want to increase your product revenue and decrease your services-derived revenue.

“Think of your services revenue as short-term, augmenting the business model while you’re building it.”

Benji, who is still consulting, agrees. “My consulting work ensures I have revenue coming in to support the business if we need it,” she says.

“Look for anything your company does — or can do — that can be monetised,” advises Clive. “But most importantly, critically analyse your business offerings. If you’re solving a real problem, your business can be customer-funded, particularly if your customers love you. I’ve seen cases where customers will pay upfront because they need your solution that badly. That’s the business you want to build. It’s also something VCs look for, because it shows you have real product-market fit.”

TOP TIP

“Focus on learning, not earning. Take the long-term view and build the skills to become an employer. Learn as much as you can about business. There are unlimited opportunities to learn available to us today. Become a generalist to succeed and focus on being a leader, and then hire the specialists.” — Clive Butkow